When is a Roth IRA Taxed?

2 min read • March 14, 2019

30 sec brief

The answer is: because you’ve already paid taxes on that income. When you contribute to your Roth IRA, it’s with after-tax income. So you don’t get a write-off like you would if you contributed to a 401k or Traditional IRA.

When is a Roth IRA
Taxed?

You might have heard of Roth IRA distributions as being
“tax-free income” upon retirement. And
technically that’s true. Once you reach
the age of 59 ½ you can start withdrawing your contributions and the money
those contributions have earned, without paying a penalty or income tax on the
money you receive. Even if you withdraw
money you’ve contributed before you turn 59 ½ you won’t pay income taxes or
penalties on the money.

Why are Roth IRA
distributions “Tax-Free”?

The answer is: because you’ve already paid taxes on that
income. When you contribute to your Roth
IRA, it’s with after-tax income. So you
don’t get a write-off like you would if you contributed to a 401k or
Traditional IRA.

However, if you start taking distributions from your Roth
IRA before you turn 59 ½ and you take out more than you’ve contributed, thus
tapping into the money those contributions have earned, you will not only get
hit with a 10% penalty on that money, you will also have to pay income tax on
those distributed earnings.

What if I’ve
Inherited my Roth IRA?

Inheritance rules are often complicated and for a definitive
answer on your specific situation, you should consult an estate attorney. But generally speaking, distributions from
inherited Roth IRAs remain tax-free.

If you’ve inherited the Roth IRA from your deceased spouse,
you can roll over their Roth IRA into your personal Roth IRA and the funds will
be treated as if they were always yours.
That means the same contribution and distribution rules apply.

If you’ve inherited a Roth IRA as a non-spouse, then you
have two options: you can take a lump sum distribution that will get taxed as
any other income, or you can roll it into an “inherited Roth IRA”. If you choose to roll it into an inherited
Roth IRA, the gains will continue to grow untaxed.

The caveat is that you will also have to start taking the
“required minimum distribution,” as determined by the IRS based on your age and
the amount of money in the account, by the end of the year following your
inheritance of the Roth IRA. Those distributions won’t be taxed, but the less
money you have in the account, the lower your gains are likely to be.

Since Roth IRAs give owners a source of tax-free income upon
retirement, they can be a great tool for helping you manage your tax
liabilities later in life. This is
especially important for people on limited budgets and people who also have
pre-tax retirement accounts like 401ks and Traditional IRAs from which they’re
required to take a minimum annual distribution upon reaching the age of 70
½.

For more information on how Roth IRAs work, check out this post, or contact an accountant. A professional will not only walk you through the ins and outs of Roth IRAs, but he or she can also help you figure out if this type of retirement account makes sense for you.

About the author

Lauren Hargrave is a writer from San Francisco who focuses on technology, finance and wellness. She follows comedians like most people follow bands and believes an outdoor sweat session can cure almost any bad mood. She’s also been writing her first novel for so long, her mom doesn’t ask about it anymore.